The stock market: horror for the rentier!

August 4, 2011

David Leonhardt of the New York Times presents this graph of the currently tanking S&P 500 stock market index and makes an apparently educated estimate that it may have another 6% to fall. The forecast isn’t based on an analysis of the source of past earnings, their stability, or likely future direction and it gives no consideration to the state of the current global political economy. It’s based entirely on a comparison with long term historical averages.

The financial press is full of such “expert” advise that considers nothing other than simple mathematical relationships. To an embarrassingly large degree, it’s the state of the art. Leonhardt suggests that rentiers use the following method when deciding how to allocate society’s wealth:

My favorite way to look at stock prices is to compare them to corporate earnings over the previous decade. By this measure, the price-earnings ratio for the Standard & Poor’s 500-stock index over the last 50 years has been 19.5. After today’s market drop, the ratio was 20.7.

So stocks would have to fall another 6 percent from their current level to return to the 50-year average.

So much of what occurs on Wall Street can be achieved with barely an 8th grade education! It’s the very nature of our absentee-owner casino capitalism.

Just a little thought would raise some rather serious questions on whether a 6% overvaluation estimate is reasonable. Profits over the past three decades or so were based almost entirely on the consumer debt, real estate, and dot.com bubbles. If it weren’t for them, we certainly would have been in at least a recession for the entire period. And how about now? We know that profits can only arise from capitalist investment, capitalist consumption, or government spending. It can’t come from anywhere else since profits are by definition the excess over the wage. Any serious analysis must start with the likelihood of future capitalist or government spending and that sure looks bleak. The record profits being achieved today are coming only from government spending and how ironic it is that the very same S&P is screaming for this sole source of profit to be shut.

Stock values are far more tenuous than most mainstream analysts imagine because profits are necessarily intertwined and ultimately dependent on the wage level. We experience occasional speculative booms but the fundamental laws must always come back in play. The key law derives directly from Keynes and is something like this: 1) high profit percentages in national income aren’t sustainable because they depend on very high levels of investment to make up for the low wage demand. Such investment can’t be profitable over the long term though because of that low level of demand; 2) sustainable profits depend on a high wage percentage in national income which therefore means sustainable profits must be low.